International Flavors & Fragrances

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

International Flavors & Fragrances Inc. (IFF) is a global leader in the creation of flavors and fragrances used in a wide array of consumer products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: IFF operates in the highly specialized field of creating scents and tastes. The company’s core business revolves around designing, manufacturing, and supplying flavors and fragrances to various industries, primarily food and beverage, and consumer goods companies (e.g., personal care, household goods, and cosmetics). The company doesn’t sell directly to the end consumer; they are a business-to-business firm.

  • Revenue Distribution: IFF’s revenues are largely driven by its two core segments:
    • Nourish: This segment focuses on flavors and includes products like savory flavors, sweet flavors, and savory ingredients. Food and beverage companies make up the bulk of this segment’s customer base.
    • Scent: This segment focuses on fragrances and includes fine fragrances and consumer fragrances. This segment’s customers range from personal care brands to high-end perfume manufacturers.
  • Industry Trends:
    • Health and Wellness: Rising awareness of health and wellness has driven demand for natural, organic, and low-sugar flavor options. The rise of “clean label” products that use recognizable ingredients has grown in the last few years, as consumers increasingly demand greater transparency about the ingredient supply chains used to make their products.
    • Globalisation: Demand for flavors and fragrances is increasing in developing countries as their standards of living increase and as Western preferences continue to spread globally.
    • Sustainability: Consumers and companies are increasingly demanding sustainable production processes from their suppliers. This puts pressure on IFF to develop environmentally friendly and ethical methods of sourcing and production.
  • Margins: IFF benefits from generally high profit margins, which is typical for specialty chemicals and ingredients businesses, but these are still not high enough to be classified as a monopoly.
    • Historically the company has been known for its resilient gross profit margins (~38%) and decent operating profit margins, both are well above what is seen with companies that sell commoditized products.

  • Competitive Landscape: The industry is primarily oligopolistic and dominated by a few large players including Givaudan and Symrise. The market share is relatively stable and depends mostly on the company’s R&D, manufacturing efficiency and client relationships. New entrants, however, are not uncommon as smaller flavour houses can innovate in niches and develop unique product offerings.

  • What Makes IFF Different: IFF differentiates itself through a combination of its innovation, geographical footprint, and long-standing relationships with clients.

    • The company spends more on research and development than its peers to drive constant innovation.
    • It has an international network of production locations.
    • Long-term relationships provide sticky revenue.

Financials Overview:

  • Recent Performance: In the most recent Q1 2024 earnings call, the company emphasized its strong financial results, with an improved revenue and margins compared to Q1 2023. It is important to note that this growth is not all organic, but also included some positive currency effects as a result of a stronger dollar, and the removal of the headwinds as a result of COVID-related restrictions.
  • Revenue and Growth: IFF has posted strong growth in the past, though it appears that the growth has slowed in recent years as companies have become more cautious about consumer expenditure. Historically, the company’s organic growth has grown at a reasonable pace, though it has supplemented this growth through acquisitions. The company has guided that organic sales should return to between 3 to 5 percent in 2024.
  • Profitability: The company is known for its high profitability and returns on capital, with net margins typically above 10 percent. But the company has been struggling with profitability in the last few quarters as a result of restructuring and acquisition-related charges. In the last earnings call they reported a 25.9% gross profit and 20.1% operating profit. It is very important to analyze if the reported “profits” are truly profits. This will be addressed in the financial analysis.
  • Cash flow: The company has generally generated good free cash flow; for FY23 free cash flow was $716 million. Although they generate cash, it is often used for heavy investments and acquisitions.

Recent Concerns/Controversies/Problems:

  • S&N Acquisition: IFF has undergone massive restructuring after acquiring Nutrition and Health division from DuPont (which was previously called S&N). The company has gone through several restructuring plans and cost-cutting initiatives. The initial acquisition was too big and has severely affected the company’s financials. They reported a $1.1 billion goodwill impairment in their 2023 annual report in respect of the S&N acquisition. While the current management seems to have taken the correct steps to resolve this problem, it will take several years to get the company back to historical profitability levels. This will be addressed in detail in the financial analysis section.
  • Debt: The acquisition of the S&N business led to IFF having a substantial debt load, which caused its credit rating to be downgraded from investment-grade status to below-investment grade. IFF has been working to reduce debt, but this remains a major risk to the business. The company has guided that a significant focus for the company’s management is reducing its debt.
  • Currency: The company’s financials are negatively impacted by fluctuations in currency rates. For example, the strengthening dollar and decline in emerging market currencies led to lower reported revenue in 2022, though the business did not change fundamentally. This same dynamic can go the other way, as has been shown in the latest earnings call.
  • Restructuring: Given the S&N acquisition, the company has had to restructure many of its businesses. The company has incurred costs for closing several unprofitable parts of its operation. All the restructuring and acquisitions have led to significant changes in financials and the operating structure of the company.

Moat Rating: 2 / 5 IFF has a narrow moat. While IFF has a good moat rating, it isn’t enough for it to be considered a strong long-term investment right now.

  1. Intangible Assets (Brands, patents): The company does benefit somewhat from its large portfolio of patents, which can protect its technology for limited periods. IFF also has many long-standing client relationships that increase their stickiness, though these are not impenetrable. The company also has some strong brands among its flavours and scents, that provide a measure of price elasticity.
  2. Switching Costs: While switching costs are not massive in this industry, once a company picks IFF as a flavour partner, it would have to redesign a lot of the product’s characteristics to switch to another flavor house, and as the relationship progresses and is maintained for years, a certain amount of knowledge sharing makes switching costs meaningful for the average client, which can make it sticky.
  3. Economies of Scale: The economies of scale in this industry are important, but not massive. Although IFF is one of the largest players in its markets, it does not have a great advantage over its peers as the cost to manufacture the flavors are minimal. This leads to smaller operations being able to compete effectively. There are no economies of scale for the consumer, as the flavours are designed for their needs, and this could be done by any producer.
  4. Network Economics: IFF does not benefit from network effects, because one client of IFF is not reliant on other clients using IFF.

Ultimately, because it has some characteristics of moats, especially among long-term clients, it makes for a company with some degree of economic advantage, though it is susceptible to competition.

Risks to the Moat & Business Resilience:

  1. Competition: IFF operates in a concentrated industry with several large competitors. New entrants can emerge with differentiated flavors and fragrances, which increases competitive pressure.
  2. Technological Innovation: The rapid pace of innovation means that any technological edge could quickly disappear with new advancements by other competitors, especially in areas such as biotechnology and material science.
  3. Loss of Clients: The loss of a major client could severely impact IFF’s sales and profitability, given the relatively concentrated customer base.
  4. Debt: If IFF cannot significantly reduce its debts, it will face higher borrowing costs and more financial pressures, which could seriously impair its ability to compete effectively in the long run, especially as debt will mean that less money is available for R&D.
  5. Economic Slowdowns: As demand for consumer goods, and especially for high-end consumer goods drops, so will IFF’s sales and profits.
  6. Commodity Pricing: Many ingredients in IFF’s products are derived from commodities. Any fluctuation in price can negatively impact IFF’s profitability.
  7. Poor Acquisitions: If IFF pursues an aggressive acquisition strategy to grow market share in new areas, it will be at a great risk of paying too much for a company or overestimating synergies, both of which destroy shareholder value.

Understandability: 3 / 5

IFF’s business model is relatively straightforward to grasp-it essentially creates specialty chemicals, and they are primarily used by other businesses. However, there are a few complexities that increase the level of difficulty in understanding the business:

  • Intricacies of product portfolio - it is hard to fully understand the intricacies of IFF’s product catalog without diving into specialized chemistry and engineering.
  • Effects of acquisitions and restructuring - this makes analysing historical trends particularly difficult.

Balance Sheet Health: 3 / 5 IFF has a decent balance sheet, but not necessarily amazing. The company’s total assets are much higher than its liabilities, but given the large amount of goodwill, its tangible assets aren’t as high. Its debt load is also very high, due to the S&N acquisition, and it’s not currently investment grade. IFF’s current assets are only about 1.5x its current liabilities, which is an acceptable ratio but nothing to be particularly happy with. A major focus for the company needs to be reducing its debt, and if it can succeed then the company can be considered to have a strong balance sheet.